Armstrong World Industries, Inc. — 2019 First-Quarter Form 10-Q
Reporting period: Three months ended March 31, 2019. Results are unaudited and presented in millions except per-share data. AWI produces ceiling systems primarily for commercial, institutional, residential, and renovation markets in the Americas. Continuing operations comprise the Mineral Fiber and Architectural Specialties segments; EMEA and Pacific Rim operations are classified as discontinued operations pending sale to Knauf.
Financial performance and position
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $242.1 | $227.3 | 6.5% increase |
| Gross profit | $91.4 | $70.8 | 29.1% increase |
| Operating income | $54.7 | $49.6 | 10.2% increase |
| Earnings from continuing operations | $36.4 | $41.2 | 11.7% decrease |
| Net earnings, including discontinued operations | $39.1 | $27.8 | 40.6% increase |
| Diluted EPS from continuing operations | $0.73 | $0.76 | Decrease |
| Diluted net EPS | $0.78 | $0.51 | Increase |
- Margins: Gross margin was approximately 37.8%, versus 31.2% in the prior-year quarter. Operating margin was approximately 22.6%, versus 21.8%. Continuing-operations net margin was approximately 15.0%, versus 18.1%.
- Segment results: Mineral Fiber sales rose to $196.7 million from $190.7 million and operating income rose to $47.6 million from $43.7 million. Architectural Specialties sales increased to $45.4 million from $36.6 million and operating income increased to $9.2 million from $8.3 million.
- Cash flow: Operating activities provided $14.7 million, compared with $26.0 million in Q1 2018. Investing activities used $38.0 million, including $43.1 million for the ACGI acquisition. Financing activities used $29.9 million, including $20.0 million for share repurchases and $8.5 million for dividends.
- Cash and liquidity: Continuing-operations cash and cash equivalents were $273.8 million at March 31, 2019; total cash including discontinued operations was $283.8 million. The company reported $157.3 million of available letter-of-credit capacity and no borrowings under its revolving credit facility or accounts receivable securitization facility.
- Debt: Total long-term debt, including current maturities, was $812.2 million. Outstanding borrowings included $540.0 million under Term Loan A, $242.5 million under Term Loan B, and a $35.0 million variable-rate industrial development bond. AWI was in compliance with its debt covenants.
- Capital allocation: AWI repurchased approximately 0.3 million shares for $20.0 million during the quarter and paid a quarterly dividend of $0.175 per share.
Material changes versus the prior comparable period
- Sales growth reflected approximately $19 million of favorable average unit value, primarily from pricing, partly offset by approximately $3 million of lower consolidated volume. Mineral Fiber volume declined, particularly in lower-end ceiling tile products.
- Operating income benefited from pricing, savings following the 2018 closure of the St. Helens, Oregon plant, the absence of approximately $7.7 million of accelerated depreciation recorded in Q1 2018, and higher WAVE joint-venture earnings.
- SG&A increased to $55.6 million from $37.5 million, primarily because of approximately $20 million of legal and professional costs related to the Rockfon antitrust litigation settlement. The company incurred $19.7 million of expenses related to that matter during Q1 2019.
- The effective tax rate increased to 26.8% from 16.6%, primarily because favorable share-based compensation deductions that benefited Q1 2018 did not recur to the same extent.
- Continuing-operations earnings declined despite higher operating income because of higher SG&A, interest expense, and income taxes. Net earnings benefited from a $2.2 million gain on disposal of discontinued businesses, compared with a $17.3 million loss in Q1 2018.
- AWI acquired Architectural Components Group, Inc. on March 4, 2019, for $43.1 million. The acquisition added custom wood ceilings and walls to Architectural Specialties and resulted in $21.2 million of preliminary goodwill.
- Effective January 1, 2019, AWI adopted the new lease standard, recognizing $28.8 million of operating lease right-of-use assets and lease liabilities. The filing states that the adoption had no material effect on earnings or cash flows.
Guidance, outlook, commentary, and risks
- Management expects the sale of the EMEA and Pacific Rim businesses to Knauf to close during the second quarter of 2019, subject to required conditions and regulatory remedies. The transaction remains subject to execution risk, adjustments, and potential delays.
- Management described Architectural Specialties growth as strong, supported by acquisitions, market penetration, and new construction activity. Mineral Fiber faced softer demand for lower-end products.
- Sales are seasonal, generally stronger in the second and third quarters. Management stated that cash flow is typically lower in the first and fourth quarters.
- Management believes cash on hand, operating cash flow, and available credit facilities will satisfy foreseeable liquidity needs based on current expectations. The filing does not provide formal quantitative revenue, earnings, or EBITDA guidance.
- Key risks include construction and economic conditions, competition and customer concentration, raw-material and energy costs, variable interest rates, debt covenants and leverage, liquidity, the Knauf transaction, WAVE, environmental obligations, litigation, cybersecurity, international operations, pension obligations, taxes, labor, and execution of cost-saving initiatives.
- Environmental liabilities were $12.4 million at March 31, 2019. AWI recorded $1.0 million of additional environmental reserves during the quarter and reported that ultimate costs at certain sites could exceed recognized amounts.
- The Rockfon litigation was settled in April 2019 and dismissed with prejudice. AWI denied wrongdoing and does not expect additional costs related to that matter.
Most important facts for investors to verify
- Completion timing, final consideration, regulatory remedies, working-capital adjustments, and cash repatriation associated with the Knauf divestiture.
- Whether Mineral Fiber volume weakness persists and whether announced pricing actions offset raw-material, energy, and sourced-product inflation.
- Integration performance and earnings contribution from ACGI, Steel Ceilings, and Plasterform within Architectural Specialties.
- Debt covenant compliance, variable-rate exposure, scheduled amortization, and the effect of interest-rate movements despite the company’s swap program.
- Cash conversion and working-capital needs, particularly given lower operating cash flow, seasonal cash requirements, and acquisition spending.
- Potential environmental costs beyond the $12.4 million recorded liability and the timing or collectability of insurance recoveries.
- The sustainability of dividends and share repurchases following the divestiture and in light of leverage and liquidity requirements.